What Does Too Big to Fail Actually Mean? – Guest Post

During the recession, the phrase “too big to fail” became part of the cultural lexicon. It was on the news every night, on the front page of newspapers, and part of the general discussion both in Washington D.C. and on Wall Street. But what exactly does the government or the media mean when they suggest a company may be too big to fail?

In capitalism, the natural order of things is that some businesses succeed and other ones fail. But when a business such as a major bank is too essential to the economy as a whole to be allowed to fail, it can be designated as too big.

The debate rages on as to what constitutes too big to fail, as well as what should be done about it. Should the government bail out these businesses, effectively intruding on the free market? Or should capitalism be allowed to run its course, no matter what the risks are to the economy as a whole?

1. How Banks Got So Big

Mother Jones reports that the nation’s 10 largest banks hold 54 percent of the country’s financial assets, up from only 20 percent in 1990. Increased mergers and acquisitions, freer reign, and the rise of interstate banking have all contributed to this growth. Many proponents of the too-big-to-fail theory suggest that the government has created the problem by refusing to impose stricter regulations on banks in the first place.

In 1999, the Graham-Leach-Bliley Act permitted banks to intermingle their commercial and investment activities, meaning that customers could now get their savings account, checking account, and insurance from the same institution without much in the way of restrictions.

This kind of banking had been banned since the Great Depression, and many think it directly caused these companies to balloon and contributed to the 2007 subprime mortgage financial crisis.

2. The Debate Over Too Big to Fail

You probably already know that in 2008, President Obama signed a $700 billion deal to bailout the major banks. The debate over whether or not this was the right decision continues, as does the debate over what to do about this problem in the future. Too big to fail isn’t going away anytime soon, and NPR reports that several Congressmen have touted the benefits of banks being so large.

Larger banks can service large firms on a global scale and handle finances that smaller, independent banks could never manage. U.S. Banks also lend to small firms in developing markets, allowing for the spread of capitalism. But other members of Congress argue that too big to fail is simply too big, and that nobody outside of Wall Street envisions the major banks as anything less than corrupt, unchecked institutions. There have been arguments that banks should be limited to $100 billion in assets or even forcibly broken up.

3. The Pros and Cons of Bailouts

According to Debate.org, the country is pretty much evenly split between those in favor of government bailouts and those opposed. Though nobody, including President Obama, wanted the bailouts to be necessary, many people believe they diverted an even greater financial crisis and preserved or even created jobs.

Many others think the bailouts only benefited rich CEOs who ought to have been held accountable in the first place, and that banks will be more likely to take risks in the future and believe the government will always rescue them. In reality, some bailouts were profitable and some weren’t. But either way you slice it, the little guy is at a disadvantage.

The phrase “too big to fail” is easily identified with the financial crisis of 2007-2009, but it’s just as relevant now as ever before. The next time you turn on the news and hear the debate raging on about enormous banks, auto companies, and insurance firms who hold the future of the economy in their power, you can remember both sides of this important issue hold weight. It’s directly related to how America defines capitalism and the freedom to make money, and how much the risk of losing that money matters.

Blogger Stacy Hilliard writes articles for Northeastern University and several other schools that offer online MBA degrees.

Posted by Mitch Mitchell on May 21, 2013

This post has 3 comments

Well, crisis started at the beginning in 2006 and I think first was felt over EU and UK. Predictions was that everything will get back to normal for 2-3 years, but it doesn’t seems so and I think more finance and economy problems are getting deeper in addition to wider gap between poverty and prosperity.Carl recently posted…How to Find The Proper Tap Adapter

Conservative economists propagate government intervention, while the hard-core capitalist see it as a narrowed down outlook. Allowing the markets to operate at their free will may do good to the economy, however, don’t be so broad minded that your brain falls off….

I took a hard and hopefully balanced look at this issue at the time. My first reaction was to let them fail, but I was only thinking about the banks. Once I thought about the automobile industry and how many jobs would be lost, thus increasing the pain even more, I realized that there was a global aspect of it all that someone had to attempt to fight off and I supported all the initiatives.

Still, if any of the companies that were helped had fallen, at that point I’d have believed they were too far gone to be fixed but all those who remained were strong enough and would absorb aspects of them. Luckily it didn’t happen, but even now some of those companies are barely surviving.